More Britons than ever are looking for a home in the sun, and it is forecast that by the year 2008 another 250,000 British people will have purchased a primary and/or a secondary residence in the Costa Del Sol area of Spain alone, bringing the number of British citizens residing in the area to one million.
Consequently, the popular hotspots on the south coast of Spain, the Algarve in Portugal, the south of France, and in northern Italy, have all seen prices increase by 20%-30% a year. And international mortgage specialist Conti Financial Services has even launched a scheme for Poland, where prices are expected to increase as the country becomes part of the EU.
In contrast to the increasingly saturated buy-to-let market in the UK, popular overseas holiday areas may have an excellent supply of would be tenants that could help finance the cost of a dream home which a borrower could use in retirement.
With house price inflation expected to slow over the next few year and even come to a halt in some parts of the South East, potential landlords could easily get better capital growth on their money from buying elsewhere in Europe and still get rental income on top.
But when it comes down to purchasing the dream home in the sun there are still plenty of pitfalls along the way. Simon Conn, senior partner at Conti Financial Services, says some brokers are still letting clients down. He says: ‘A lot of brokers will take the easy way out and remortgage the client’s property in the UK. The problem is the client then goes over there with cash and sometimes does not get proper legal advice to make sure they get true title on the property abroad, and they do not know what they are signing.’
The alternative to raising finance on the client’s UK property is to take out a foreign mortgage on the overseas property. This should at least mean that the proper searches are carried out on the property before the lender approves the mortgage.
With interest rates in the Euro zone at an extremely low level, the British should in theory be able to get cheaper rates on the continent. But the reality is, that there is far less choice in terms of lenders and products on the continent compared with the UK, with banks tending to trade at a higher margin, and most mortgage rates are typically around 4% in the Eurozone.
And although Conti Financial Services estimates that 75% of its clients will rent their overseas property, true buy-to-let mortgages are still not available. Landlords can rent out their property but the lender will not take rental income into account when determining how much they can borrow on the property. The vast majority of products available on the continent are variable rate repayment mortgages. Given the limited choice and competition in the market, some of the best deals are currently being offered by the continental affiliates of British banks and building societies.
But one key point is that the amount landlords are allowed to borrow through lenders operating on the continent can be significantly less than in the UK. The way lenders take individual circumstances into account can also be unfavourable compared with the UK. Lenders on the continent will usually say that the maximum borrowings cannot exceed one third of income. Banco Halifax Hispania (BHH), for example, stipulates expenditure on loans cannot exceed 35% of net income.
Mike Boles, director at Savills Private Finance, explains: ‘Generally speaking it is a harsher method of calculation that in the UK. If you have got a few buy to lets in the UK some lenders will say they have to take all that debt into consideration and that the income you get from it is irrelevant.’
Maximum loans to value (LTV) are also lower than in the UK, and taking the LTV above 60% can often be detrimental.
Boles says: ‘The absolute minimum you have to put down is 15%. Banks offer better deals if you put down more. That is where your UK property comes into play. If you were intending to put down 15% but I could give you a better deal for 30% then maybe you would want to raise some money on your UK property. ‘
Following the substantial rises in property values in the UK, taking some equity out of a UK home to at least finance the deposit on the continental home will appeal to many. Financing the home with a Euro mortgage can make sense if the borrower is planning to help pay for their new property with rental income. But this can carry its own risks especially if the pound continues to fall further against the Euro as it has so far this year.
Boles says: ‘Obviously UK borrowers are earning in pounds. If there is a shortfall in rental income you are transferring money out all the time. If the pound keeps dropping in value that’s going to cost you more to service the loan.’
The affiliate of Norwich & Peterborough (N&P) Building Society, Norwich & Peterborough Spanish Home Loans (NPSHL) specialises in the British expatriate market and will lend in Sterling using UK style income multiples to calculate the loan. NPSHL will use a multiple of three times income plus one times second applicant or two and half times joint.
But Joe Gomez, Spanish development manager at N&P, warns that letting a second home may not be as easy as people think. ‘The laws are very draconian and not in the favour of the landlord. You have to find an agent to look after it and that is 20%-25% of rental income straight away,’ says Gomez.
Under Spanish law if a person holds tenancy for over 11 months then they can automatically earn the legal right to stay in the property for a further five years, so it is important to have a short term contract. If a tenant does not pay the rent then the case can take up to a year to be heard through a leisurely Spanish legal system.
Lease back schemes offer an alternative for those wishing to rent out their second home abroad. Through lease back the developer typically sells the property to raise the capital for the building costs and then turns themselves into a management company to lease the properties from the owners. The owners agree to lease the property for a minimum term, typically of ten years, and are allocated a fixed number of weeks a year when they can use the property themselves. Lease back schemes can allow the buyer to get a guaranteed share of rental income in Euros to pay the mortgage, which are typically provided by the bank that financed the development in the first place.
Savills Private Finance says its lease back scheme in the French Alps, for example, is selling very quickly. Under French law if a borrower commits to lease back the property for at least 20 years they can also escape the French equivalent of VAT.
Boles says: ‘There are tax reasons for people going into lease back besides renting. On your own you have got to find an agent to do it all for you. While the potential returns might be higher on your own you may find it hard keeping occupancy up.’
The main pitfalls of buying abroad can be legal. Under French law, on death the property can automatically go to the children and not the partner. In rural areas of Spain and Portugal you could even manage to buy a property without full title and legal ownership.
These pitfalls can be avoided by using the right specialist lawyer. The website of the Federation of Overseas Property Developers, Agents and Consultants, www.fopdac.com, provides legal contacts.
Taking out a mortgage witha foreign lendershould ensure that proper searches are carried out.
Overseas lenders do not take rental income into account when determining how much they will lend.
Releasing equity out of a UK property can help to finance the deposit on the foreign loan.